Transcript of "The FHA does not produce sustainable homeownership"

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The FHA Does Not Produce
Sustainable Homeownership
Government Involvement in Residential Mortgage Markets
Sponsored by: the Federal Reserve Bank of Atlanta
Edward Pinto, Resident Fellow
American Enterprise Institute
December 5, 2013
The views expressed here are those of the author alone
and do not necessarily represent those of the American
Enterprise Institute.

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FHA has a history of abusive lending
―We have been fighting abuse, fraud, and neglect of the
FHA program that has destroyed too many
neighborhoods and too many families' dreams of
homeownership for more than 25 years….The FHA
program has a national default rate 3 to 4 times the
conventional market, and in many urban neighborhoods
it routinely exceeds 10 times. In addition, the FHA
program is hemorrhaging money….‖
Statement by the late-Gale Cincotta (a long-time community activist) made
before the Subcommittee on Housing and Community Opportunity of the
House Financial Services Committee, April 1, 1998

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FHA’s Original Goal: End ‘Mortgage’
Becoming Another Word for Trouble
• When established in 1934 by Congress, FHA implemented
commonsense underwriting standards—increasing down
payments to a minimum of 20%, establishing reliable and
speedy loan pay downs with a 15-20 year loan term, using a
residual income test to assure a borrower’s reasonable
ability to pay, and requiring demonstration of a good credit
history.
▫ From 1934 to 1960, these standards helped millions upon
millions of Americans safely and confidently achieve the
American dream of eventually owning their home free and clear
of a mortgage and helped increase the homeownership rate to
new heights.
▫ Over its first 20 years, the FHA paid only 5,712 claims out of 2.9
million insured mortgages for a cumulative claims rate of 0.2%.

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FHA Underwriting Standard--1936
• ―To be economically sound, a mortgage must be
based on good security and involve a borrower
with characteristics and income which indicate a
strong probability that the debt will be paid off
in accordance with conditions of the transaction.
Such a mortgage transaction is mutually
advantageous to the borrower, the mortgagee,
and the Federal Housing Administration.‖

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FHA and HUD Made Foreclosures
Commonplace Across America
• Starting in the late-1950s Congress imposed
increasingly lax standards for FHA insurance.
• From 1975 to 2011, over 3 million FHA borrowers would
lose their homes to foreclosure.
• Beginning in the early-1990s, powerful lobbies,
politicians, and HUD replicated FHA’s
abandonment of commonsense underwriting at
Fannie Mae, Freddie Mac, and throughout the
mortgage market.
▫ 8 million families would experience foreclosure from 2007
to the present.

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Cross-subsidies Pay for Catastrophic
Losses in Working Class Neighborhoods
• The five zip codes in Atlanta with the highest projected
failure rates had rates that ranged from 24 to 30 percent.
• The five zip codes in Atlanta with the lowest projected
failure rates had rates that ranged from 2 to 4 percent.
• The five zip codes in Miami with the highest projected
failure rates had rates that ranged from 21 to 33 percent.
• The five zip codes in Miami with the lowest projected
failure rates had rates that ranged from 4 to 6 percent.
See Appendix I.

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Harm to a Family’s Credit
• Foreclosed borrowers denied access to most forms of credit
for 3-to-5 years and limits on the ability to rent.
▫ Denied the opportunity to build equity, provide security for their
family, and have the down payment for their next home as their
family grows.
• At a projected foreclosure rate averaging 10 percent, nearly
1 in 5 FHA loans is delinquent 30 days or more at least
once in a two year period.
• In a working class neighborhood with a projected
foreclosure rate averaging 17 percent*, nearly 1 in 3 FHA
loans is delinquent 30 days or more at least once in a two
year period.
• Mortgage delinquencies negatively impact credit
scores, access, and credit cost (see Appendix B).
*Foreclosure rate for FHA borrowers with a FICO score of 620-659.
NightmareAtFHA.com

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Financing Failure, Zip by Zip
This is Atlanta, GA zip code 30349.
With a 20.6% projected foreclosure
rate for 2009-2010, one in five
families may well lose their homes.
In 2009, the FHA or VA guaranteed
seventy-eight percent of home
purchase loans in that zip code.
Image Source: www.Zillow.com
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The relevant public policy question
• What is the tolerance for failure for loans under
such a government program?
• What is the tolerance for failure given the
concentration of failure that occurs with respect
to working class families and neighborhoods?
• Answer: These common sense reforms will allow
FHA to reduce its cycle default rate to 6-7%.

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APPENDIX C
REDUCE COVERAGE BELOW 100%
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• VA pays up to an average of 25%, averaging 25% while
FHA pays up to 100% of the claim amount, averaging
63%.
• FHA’s loss rate is an estimated 5 times the VA’s (2 times
the incidence and 2.5 times the severity).
• The VA charges 1/3 FHA’s premium (present value basis).
• VA Issuers absorb 1.6 times the overall loss rate
compared to FHA issuers for the same fee.

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APPENDIX C CONTINUED
VA’S 25% COVERAGE
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• Did not deter ability to play a countercyclical role.
• VA’s volume tripled from 2007 to 2009.
• In 2009 the VA’s median FICO score was 705, similar to the FHA’s
median of 694.
• Did not deter ability to serve underserved borrowers
in a sustainable manner.
• In 2005, 43% of the VA’s originations had a FICO between 600679, virtually identical to FHA’s 44%.
• VA has experienced substantially lower serious
delinquency rates than the FHA for decades and are
currently half the FHA rate (2001-2012).

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APPENDIX D
Excessive Seller Concessions
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• In July 2010, FHA Commissioner Stevens proposed
eliminating seller concessions >3%.
• FHA allows up to a 6% seller concession vs. 3% for conventional
market:
• The incidence of concessions and the average concession is highest
for loans <$180,000 (lowest loan size for which FHA provided data).
• When concession is >3%, default rate 1.9 times that of loans
where 0%
(1/3 of FHA loans below $180,000 have a 0% concession.
• When concession is >3%, default rate 1.3 times that of loans
where >0% and <=3%.

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APPENDIX E
Utilize Residual Income Test
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• VA requires underwriters to identify and verify income
available to meet:
• The mortgage payment
• Other shelter expenses (includes utilities and maintenance)
• Debts and obligations (includes job related expenses such as
child care)
• Family living expenses
• Residual income needs
• The resulting debt-to-income ratio (DTI) is secondary to
residual income as an underwriting factor.

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APPENDIX G: Countercyclical Policies
Designed to Lean Against a Boom
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• Countercyclical capital stress test:
▫ A risk-based capital model to determine the amount of
capital that is sufficient for the FHA to maintain adequate
capital to cover all credit losses which are projected to
occur at the higher of the rates determined as follows:
 Consistent with a nationwide economic recession of average
severity based on nationwide economic recessions since 1950 or
 The result of house prices reverting to their long term value
trend. Long term value trend shall be determined over a multidecade and shall utilize fundamental trend values such as
replacement costs, rents, household income, or consumer prices

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APPENDIX G: Countercyclical Policies
Designed to Lean Against a Boom
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• A Countercyclical Loan-to-Value ratio (CCLTV)
reflecting the underlying sustainable lending value
trend.
• The standard for the CCLTV shall consider the
sustainable lending value based on long-term trends, in addition
to the current price, thus creating a standard for a
countercyclical loan-to-value ratio.
• The sustainable lending value trend shall take into account the
result of house prices reverting to their long term value trend.
• Long term value trend shall be determined over a multi-decade
and shall utilize fundamental trend values such as replacement
costs, rents, household income, or consumer prices.

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Appendix I: Disproportionate Impact
on Working-Class Communities
Neural Net Predicted 90+ Rate By Risk Bucket
1st & 4th Interthinx Risk Index Quartiles
45%
40%
35%
90+ Rate
30%
25%
20%
15%
10%
5%
0%
Neural Net Predicted 1st Quartile 90+ Rate
Neural Net Predicted 4th Quartile 90+ Rate
Loans to FHA borrowers in zip
codes with a higher fraud risk
score (FRS) perform worse
than loans in zips with a lower
FRS, even when borrower risk
factors such as FICO
score, down payment, and DTI
ratio are held constant across
245 risk buckets. An FHA
borrower in a zip code in the
4th quartile (the 25% of the
zips with the highest FRS), on
average, had a 31% higher
likelihood of being 90+ days
delinquent compared to a
borrower with the same risk
factors living in a zip in the 1st
quartile (the 25% of the zips
with the lowest FRS).
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Appendix I: Disproportionate Impact
on Working-Class Communities
From a study showing
that an FHA borrower
living in a zip code in the
fourth quartile (those
with a mean Equifax
Risk Score of 519 to 673)
had an average 45
percent higher likelihood
of being 90+ days
delinquent compared to
a borrower with the same
risk characteristics
(measured across 245
risk buckets) living in a
zip code in the first
quartile (with mean
Equifax Risk Scores of
721 to 826).
NightmareAtFHA.com

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Appendix I: Harm To WorkingClass Families and Communities
From a recent study
where 19 of 23 cities had
higher FHA
projected foreclosure
rates in low-income zip
codes than in middleincome zip codes.
Replicates the National
Training and Information
Center’s’ 2002 study
for the same 22 cities (did not
include Pittsburgh).
That study found 21 of
22 cities had higher
FHA loan default rates
in low-income census
tracts than in middleincome census tracts.
Low income zip = <50% of median
income
Middle income zip = 80%-120% of
median income
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